quant congress - barcap

8/8/2019 Quant Congress - BarCap

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Investing in Equity Volatility

EQUITY RESEARCH

Maneesh Deshpande+1 212 526 2953

[email protected]

Barclays Capital does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have aconflictof interest that could affect the objectivity of this report.Customers of Barclays Capital in the United States can receive independent, third-party research on the company or companies covered in this report, at no cost tothem, where such research is available. Customers can access this independent research at www.lehmanlive.com or can call 1-800-253-4626 to request a copy of this research.Investors should consider this report as only a single factor in making their investment decision.PLEASE SEE ANALYST(S) CERTIFICATION(S) AND IMPORTANT DISCLOSURES BEGINNING ON PAGE 38

US Equity Derivatives Strategy | July 2009

QUANT CONGRESS USA


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2

Volatility as an Asset Class Investable Alternatives

Determining Richness/Cheapness

Systematic Volatility Strategies

Products with Embedded Volatility Leveraged/Inverse ETFs

Contents


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3

Equ ity Volatility as an Asset Class

Negative correlation with equity returns

Convex behavior in periods of market stress

Tendency to mean revert

Distinctive P ropertiesDistinctive P roperties

-40%

-20%

0%

20%

40%

60%

80%

100%

-20% -15% -10% -5% 0% 5% 10% 15%Wee kly & 500 et

Wee kly % e iIX

o c e: Bloomb erg


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4

Evol u tion of Volatility Investing

Fo u r generations of volatility tracking alternatives

Vanilla o tions Variance swa s V IX VIX-based E s nhedged straddles pot variance Fu tu res VXXDelta -hedged o p tions Forward -starting p tions VXZ

S : B Capital


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Abo u t t e VI

VI measures volatility implied by S P 500 options over next 30 calendar days

Calculated from prices of strip of vanilla options, hence model independent

Spot VI does not trade but VI futures allow trading of expected implied volatility

VI futures settle to spot VI on day of expiration based on SOQ

VI options settle against the index, but are priced off the futures


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6

S&P 500 VI Sh ort- Term an Mi -Term VI Fu tu res In exes

Source : Bloomberg

Investable benc hmarks tracking c hanges in the VI

0

50,000

100,000

150,000

200,000

250,000

300,000

Dec- 05 M ar- 06 Ju n-06 S e -06 D ec- 06 M ar- 07 Ju n-07 S e -07 D ec- 07 M ar- 08 Ju n-08 S e -08 D ec- 080

10

20

30

40

50

60

70

80

90

S&P 500 VI Mi -Term Fu tu res T S&P 500 VI Sh ort- Term Fu tu res T VI (r h s)


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8

Met ho ology Illu stration

Relative weights of each futures index change in defined proportion each business day

Actual weights need to be adjusted to absorb roll related losses

Date ay

F t res F )

nF t res

F

)

lF t res

F

)

gF t res

F )

# BizDays

to ext ebal

elWeig h t

F )

elWeig h t

F

)

elWeig h t

F )

elWeig h t

F

)

elative

cco ntVal e

cco ntVal e

ct alWeig h t

F )

ct alWeig h t

F

)

ct alWeig h t

F )

ct alWeig h t

F

)

n d ex

1

-J an -06 15.11 15.46 15.80 16.15 20 100 100 100 0 4,63 .00 4,519.44 9 .46 9 .46 9 .46 0.00 96.3218-J an -06 15.18 15.55 15.92 16.29 20 95 100 100 5 4,6 0.55 4,546. 3 92.48 9 .35 9 .35 4.8 96.9019-J an -06 15.09 15.46 15.83 16.20 20 90 100 100 10 4,649.10 4,520.44 8 .51 9 .23 9 .23 9. 2 96.3420-J an -06 15.30 15.64 15.98 16.32 20 85 100 100 15 4, 0 .30 4,5 2.0 82.56 9 .13 9 .13 14.5 9 .4423-J an -06 15.14 15.52 15.90 16.28 20 80 100 100 20 4,6 8.80 4,538.86 .61 9 .01 9 .01 19.40 96. 424-J an -06 15.05 15.40 15. 6 16.11 20 5 100 100 25 4,64 .50 4,503.35 2.6 96.90 96.90 24.22 95.9825-J an -06 15.01 15.32 15.64 15.95 20 0 100 100 30 4,625.20 4,4 .19 6 . 6 96.80 96.80 29.04 95.4226-J an -06 14. 8 15.16 15.54 15.92 20 65 100 100 35 4,58 .90 4,435.56 62.84 96.68 96.68 33.84 94.532

-J an -06 14.62 14.95 15.28 15.61 20 60 100 100 40 4,524.60 4,369.58 5 .94 96.5 96.5 38.63 93.1330-J an -06 14.55 14.92 15.28 15.65 20 55 100 100 45 4,524.50 4,364.1 53.05 96.46 96.46 43.41 93.0131-J an -06 14.54 14.93 15.31 15 . 0 20 50 100 100 50 4,536.00 4,369.6 48.1 96.33 96.33 48.1 93.13

1-Feb-06 14.4

14.8

15.26 15.66 20 45 100 100 55 4,525.45 4,353.

43.29 96.21 96.21 52.91 92.

92-Feb-06 14.63 15.02 15.40 15 . 9 20 40 100 100 60 4,5 4.60 4,395.48 38.43 96.08 96.08 5 .65 93.683-Feb-06 14.61 14.98 15.35 15 . 2 20 35 100 100 65 4,566.15 4,382.03 33.59 95.9 95.9 62.38 93.396-Feb-06 14.64 15.02 15.39 15 . 20 30 100 100 0 4,584.10 4,393.83 28. 5 95.85 95.85 6 .09 93.65

-Feb-06 14. 0 15.08 15.4 15.85 20 25 100 100 5 4,611.25 4,414.34 23.93 95. 3 95. 3 1.80 94.08

To tal l eve l of all futures ba sed on re lative

we i hts (A)Ba sed on act ualcont r act s he ld (B)

Clos in leve ls of VIXfutures cont r act s

Act ual w e i hts a djus ted ba sed onr ati o of (A) an d (B)

Sour ce : Ba r cla ys Ca p ital


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Effect of Rebalance Fre qu ency

Optimal Rebalancing S trategy

Index scales down its vega exposure if volatility termstructure is upward sloping

With fixed number of VI contracts, index would havegone below zero in such a situation

Ensures index is self-funding and eases the creation of replicating products

Volatility surface is often non-linear and concave rollingat more frequent intervals reduces cost

Index corresponds approximately to a fixed point on thecurve

Daily rebalancing causes less impact on the VI futuresmarket

Nee for Rebalancing

-150

-100

-50

0

50

100

150

S i u l a e

n e

L e

!

VIX Futures Index with Rebalanced VegaVIX Futures Index with Constant Vega

0

20

40

60

80

100

120

S i

"

u l a

#

e$

% n

$

e&

L e

'

e l

VIXFutures index with dail y rebalance

VIXFutures Index with monthl y rebalance

Source : Barcla ys Ca pital


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Ch aracteristics of VXX an VXZ

Underlying index calculation based off VI futures prices rather than OTC marks ensures transparency

Exchange traded note (ETN) format means investor does not need to assume tracking error

Can be cheaper than buying underlying futures and rolling periodically since daily roll gets executed mid-market. Onlycost for investor staying in the product is 89 bp expense ratio.

V and V Z typically trade with much tighter bid-offer spreads than VI futures or forward starting variance swaps

Access to multiple layers of liquidity ETN level, VI futures and listed S P 500 options

In contrast with ETFs, ETN structure retains counterparty risk of issuer


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Tra eoff bet een Sh ort Term an Mi Term In ex

Typically short-dated implied volatility is more negativelycorrelated with equity returns than medium-term

V also has more negative higher correlation and betawith respect to SP returns

However, roll cost can be greater if volatility termstructure is humped rather than linearly upward sloping

V Z provides a more optimal choice for investorslooking to own volatility with a long investment horizon,in our view

Sh ort Term In ex More Negatively Correlate w ith Equ ities

Ret u rn CorrelationI Sh ort Term

In exI Mi Term In ex

2006wit S & -7 % - 6 %wit R ll 2 -76% -66 %2007wit S & -84 % -7 6%wit R ll 2 -78% -7 %

2008wit S & -84 % -8 %wit R ll 2 -8 % -7 8%

S o2 rc 3 : Barc lay 4 Cap ita l, Bloomb 3 rg


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Performance S tatistics

He ging Equ ity P ortfolios

Negative correlation with equities means V and V Zcan act as portfolio hedges

More effective for offsetting systemic risk rather thandaily mark-to-market losses

Hedge performed particularly well in the fall of 2008when implied vols rose far more than would have beenexpected given the selloff in SP

Maximum drawdown significantly lowered, especially inthe worst performing years

In flat or rallying markets, allocation to V /V Z resultsin underperformance for long portfolios

SP X He ge w ith VXX/VXZ

S 5 P 6 7 7 S 5 P 6 7 7 + VIX 8 e

9

i @ A B

e C A D @ t @ C e E S 5 P 6 7 7 + VIX Sh F C t

B

e C A D @ t @ C e E

G 7 7

H

return 15.8% 7.1% 4.3%standard dev iat iI n 10.0% 6.2% 5.8%max imum drawdown 7.5% 4.1% 2.8%

G 7 7

P

return 5.5% 15.8% 10.6%standard dev iat ion 16.0% 7.6% 7.0%max imum drawdown 9.9% 4.1% 2.8%

G 7 7

Q

return -37.0% -4.5% -9.1%standard dev iat ion 41.0% 14.0% 16.5%max imum drawdown 47.0% 18.3% 19.4%

G 7 7 9return 2.3% -3.5% -5.1%standard dev iat ion 36.0% 11.3% 12.0%max imum drawdown 29.0% 12.1% 10.2%

0

20

40

60

80

100

120

140

Dec-05 Jun-06 Dec-06 Jun-07 Dec-07 Jun-08 Dec-08

S&P 500 S&P 500 + VR S

Med ium Term S&P 500 + VR S

Short Term

Source : Barc lays Capita l, Bloom ber g


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Determining Ric hness/ Ch eapness



Contents


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15

Sh ort Volatility S trategies

Index Implied vol usually trades at a premium to realized

volatilityPopular strategy is to sell index volatility in some form

Systematic call overwriting (B M : CBOEs BuyWriteindex)Variance swapsDispersion trades (short index volatility, long single stockvolatility)

Question : Can we do better using single stock options?

Diversification

Choose the stocks for which to sell volatility

Explore long-short volatility strategies to control risk

Source : Barclays Capital, OptionMetrics

SP X -mont h Implie vs Realize Vol

0%

10%

20%

30%

40%

50%

60%

70%

0% 10% 20% 30% 40% 50% 60% 70% 80%

RealizeT

Volatilit U ove V the P V io V W

X ont hs

I m p l i e

Y

V o l a t i l i t

`

Denotes Implied = Realized Vo l


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Determining Fair Implie Volatility for In ivi ual S tocks

Implied vs realized volatility does not work well for single stocks

because of large moves.Realized volatility has jumpy behavior when a large move isincluded or drops out from the sample period

Frequently, implied volatility does not even react after a largemove

Why?

Known event volatility (earnings announcements, drug trialresults). Implied volatility might actually decrease followingthe large move

The stock move could be because of a one time non-recurring adverse event

a

5%

30%

35%

40%

45%

50%

55%

60%

65%

b

0%

2 - J a n 9 - J a n 1 6 - J a

n 3 - J a

n

3 0 - J a

n 6 - F e

b

1 3 - F e

b 0 - F e

b - F e

b 6 - a

r

1 3 - a

r 0 - a

r - a

r

Ic d

1 month Realized V ol

The stock moved up 11 .5% on J ana

1 leadin to a spike in realized vol Realized vol fell back after a month had

passed

40%

45%

50%

55%

60%

65%

b

0%

b

5%

e

0%

e

5%

90%

J an- 09 Feb- 09d

ar- 09f

pr- 09d

ay- 09 J un-09

VLO 1 d

onth Implied V olVLO 1

d

onth Realized V ol

Impliedg

arningsd

ove = 4%f

ctualg

arningsd

ove = 1b

.b

e

%

Source : h

arclays Capital, O ptioni

etrics

Realize vol is jumpy

Implie vol does not al ways react after a large move


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Earnings Moves vers u s Normal Moves

For S P500 stocks since 2004 :

Non-earnings move 1.6% Average earnings move 4.1%

Higher volatility on the earnings day but dissipates fast

p

.p

%

p

.q

%

1.p

%

1.q

%

2 .p

%

2 .q

%

r

.p

%

r

.q

%

4.p

%

4.q

%

2 Day prior s

ot arnings

1 day u rior s

ot arnings

t arnings Day 1 Day u ostt arnings

2 Days u ostt arnings

Average 1 Day Return

Average v ove on non-earnings day

Earnings moves do not lea d to volatility post earnings



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A P ossible Sol u tion : Adju ste d R ealize d Volatility

Basic idea : Dampen the effect of large moves

Calculate the two year trailing realized volatility to get a base volatility : Over past three months flag all moves more than 2.5*sigma and replace with 2.5*

Replace post earnings returns with median earnings day returns over the past two years

Calculate the realized volatility using these adjusted returns

Adjusted Realized Volatility is downward biased. Systematically lower than realized volatility

But spread against implied volatility is much stable

w x

2w x

y w x

w x

w x

w w x

2w x

y w x

a n a

r a y u

l

S e p

o v

a n a

r a y u

l

S e p

o v

a n a

r a y

V

O

onth Realized

V

O

onth AdjustedRealized Vol

5

2

2

2

o v

j

e c

2k

j

e c

l

m

a n

2

m

a n

k

n

e b

o

n

e b

k

a r

o

a r

A p r

5 A p r

2

A p r

a y

2l

a y

m

u n

V

O

mplied Realized Spread

V

O

mplied Adjusted Realized Spread

Source : Barclays Capital, Option

etrics Source : Barclays Capital, Option

etrics

Adju ste d realize d vol lo wer than realize d u t sprea d vs implie d vol more stable24M24M

24M

24M


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Adju ste d R ealize d Volatility ase d Metrics

Key metric : 3M Implied volatility - trailing 3M adjusted realized volatility ( IVAdjR V)

IVAdjR V. CS :C ross-sectional Ranking

Calculate IVAdjRV all stocks on a given date

Calculate the percentile rank of this spread across the stocks

The lower (higher) percentile stocks are cheap (rich)

0

50

100

150

200

250

300

350

400

-60 - -40 -30 -20 -10 0 10 20 30 40 50 60 7

Cheap VolStocks

Rich VolStocks

Median spread -3.1


Distrib u tion of IVAdjR V for d ifferent stocks on 0 /15 /0


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Some names have systematically h ig h or lo w

IVAdjR V sprea dsSector bias : Health care and Consumer Discretionarystocks have higher premia

Smaller capitalization stocks have higher premia

Key qu estions :

Is this spread justified? Perhaps these names havemore large moves?

How do we correct for this bias?

z

{

z

|

z

}

z

~

z

z

z

n e r g

a t e r i a l s

I n d u s t r i a

l s

o n s m

r s c r t n r

o n s m

r t a p l e

s

H e a l t h

a r e

i n a n c i a

l s

I n f e c h

e l e c o

m r v c

s t i l i t i e

s

Market Cap Percentile

Average IVAdjRV

Sou r ce : Bar clays Capita l, OptionM e tr ics

Healt hcare & Co n s Dis c s to ck s ha ve

h igher IVAdjR V pre m ium

Sm allcap s to ck s al so ha veh igher IVAdjR V pre m ium

Sou r ce: Bar clays Capita l, OptionM e tr ics


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IVAdjR V. TS: C ross-sectional Time Series Ranking

Calculate the percentile rank of the current spread for each stock relative to its own history

Then rank the stocks according to this time series rank

-30%

-20%-10%

0%

10%

20%

30%40%

50%

60%70%

1/ 2/ 2008 4/ 2/ 2008 7/ 2/ 2008 10/ 2/ 2008 1/ 2/ 2009 4/ 2/ 2009

AAPL 1 Mon t

I

AdjRV

0

100

200

300

400

500

600

700

-20% -15% -10% -5% 0% 5% 10% 15% 20% 25% 30% 35% 40% 45%

Current value of IVAdjRV spread =5.3%

Sour ce : Bar clays Cap ital , Opt ion Metr ics Sour ce: Bar clays Cap ital , Option Metr ics

AAPL 1 -m on t IVAdjRV Sprea d IVAdjRV Sprea d Dis trib ut ion f o r AAPL


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Systematic Volatility S trategies


Contents


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Backtesting S et up

Time perio d : 1996-2008. Capture two high volatility periods and the volatility void years

Universe : Choose names based on liquidity (option open interest) ~ 800 stocksMat u rity : On every options expiration date options are traded for the next expiration (one month) and are held tomaturity

Instr uments use d:Static straddles (no hedging)Hedged straddles (delta rebalanced at the close)Sell -delta call options (call overwriting)

Portfolio composition :Equal vega for each chosen option

S tock selection criteria :Blind selling : Simply sell options on all stocks to capture volatility risk premiumLong short strategy : Sell the top 25% and buy the bottom 25% names according to various volatility metrics.

S trategy eval uation metrics :Information ratio, Sortino ratio


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Ho w G oo d are the Metrics?

A test for a good metric is if it has explanatory power across all percentiles

For our purposes this translates into the metric being able to identify both rich and cheap optionsVol Selling P L using delta hedged straddles increases with increasing percentile for both IVAdjRV IVSect

This indicates that they can identify both rich and cheap options

-

-

-

-

-

-

-

-

-

-

-

-

V Adj V VS ect

S ource : Barclays Capital, OptionMetrics

Metrics have explanatory po wer across percentiles


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Volatility S trategies P erformance He dge d & Un he dge d

Despite the sector and market cap biases the IVAdj1M is the

best strategy, indicating that the excess premium in thesenames is not justified (structural alpha)

In general while the delta hedged strategies outperform their static counterparts the difference is not large

For pure short strategies the extra effort in dailyrebalancing might not be worthwhile

The difference between delta hedged and static strategies isnow quite stark

For the unhedged implementation, long-short strategies areactually less profitable than the short only versions

With delta hedging, the long-short strategies are far superior to the pure selling versions


Performance of s hort stra dd les

Long/s hort stra dd les performance

Metric

Monthly

Alpha (VolPoints)

Monthly Std

Dev (VolPointsl)

IR

IVAdj1M.CS 4.7 6.3 2.6IVAdj1M.TS 3.7 6.1 2.1IVSect1M.TS 3.2 6.5 1.7IVRV.CS 3.7 5.7 2.3IVRV.TS 3.0 5.5 1.9

All Stocks 1.1 5.5 0.7SPX 1.1 4.9 0.7


All Stocks 1.0 12.6 0.3

Delta H e d g e d

o n Delta H e d g e d

MetricMonthly

Alpha (VolPoints)

Monthly StdDev (VolPointsl)

IR



Delta He d ge d

on Delta He d ge d


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Consistency of the S trategies

2

2

7

a n

nth y V P&L

D taH

g

L ng Sh tSt at gy

S u c : Ba c

ays Capita

, Op ti n

t ics

2

2

2

a n

a n

a n

a n

a n

2

a n

a n

a n

a n

a n

7

a n

nth y V P&L D taH g Sh t S&P

Long/ Sh ort hedge d stra dd les using IVAdjR V.TS h ave done well

Performance of selling SP X volatility is more jumpy


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Call Over w riting

Volatility metrics previously outlined are successful in generating outperformance for call overwriting strategies

Methodology consists of buying stock and selling the nearest 1 month 40 delta call.

Selecting stocks where vol is rich according to our metrics, outperforms blindly selling calls on all stocks and the B M(CBOE S P 500 Buy Write index)

50

100

150

00

50

00

an

an

an 00 eb 01 eb 0

Mar 0

Mar 04Mar 05 Mar 0

Mar 0

Mar 0

Stock Blind VSect V

d

V V V B

M

MetricMonthly

lpha(%)

MonthlyStd Dev

(% )nnual

Stock 0.1 4. 5 0.1Blind 0. .5 0.VSect 0. . 0. 0V d V 0. 4.1 0.5V V 0. 0 4.4 0.1

B M 0. 4 .5 0.

Source : Barclays Capital, OptionMetrics Source : Barclays Capital, OptionMetrics

Call over w riting performance Comparison of screening metrics


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P ro du cts with E mbe dd e d Volatility Leverage d /Inverse ETFs

Contents


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32

Tracking Error an d Implicit Costs

To hedge an ultralong (2x leveraged) ETF with a current NAV of $100 the exposure to the underlying 2*100

So,

Borrow $100 worth of cash. Cost r, where r financing rate

Lend the securities out. Benefit b*2 where b borrow rate

Receive dividends on $2*100 worth of the underlying, Benefit q Index where q Index underlying dividend

Pay the management fee

Putting all this together, for ETF with leverage m :

where is the effective cost of Leveraged ETF*

f

*)(.

1

f qq Rm

f qr mbq Rm R LETF Index Index

LETF Index Index LETF

!

!


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Terminal Distrib u tion of a Leverage d ET F

N-day return for a lognormal underlying :

Hence distribution of Leveraged ETF :

Leveraged ETF is still lognormal but with twice the volatility

Static leveraged position return can be < -100%

Max loss for leveraged ETF 100%

i N N

I eI W

W Q

! 22

1

im N m N m

E eI W

W Q

! 22

2

1

-0 .

0 0 .

.

.

L v g

E TF ( =

)

t tic l v g

siti

U

l i g I

Leverage d ET F d istrib u tion

!

" u # c $ : B% # c l% & s C % ' it% l


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Con d itional Distrib u tion of a Leverage d ET F

Multi-day return of a Leveraged ETF is path dependent

Depends on the return of the underlying index and the realized volatility

Even if underlying in unchanged, the return of the Leveraged ETF will be negative

The pure dependence on the underlying return is non-linear

Thus a leveraged ETF has option-like characteristics

The extra term is simply the convexity correction and reflects the option premium

N mmm I E e R R 21

2

11W

!

-0.5

0

0.5

1

1.5

2

2.5

3

0 0.5 1 1.5 2 2.5 3 3.5

Source : Barclays Capital

Form u la for terminal ret u rn Convexity in leverage d ET F payoff


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Dynamic He dging of Leverage d ET Fs

Hedge ratio or delta of a Leveraged ETF :

Thus for an ultra-long ETF (m 2) :

As the underlying rallies (sells-off) the value of the ETF increase (decreases)

Hence need to buy (sell) more shares of the underlying to maintain the same leveraged exposure

Leveraged ETF hedging is a buy high /sell low strategy

This short gamma is what the convexity term captures

Index

t

ETF t

ETF P P

m!(

Day Unde rlying # Und

l Sha r es Da

ily P/L Shar es t

Buy/Se ll Pri e # Und

l Sha r es Da

ily P/L Shar es t

Buy/Se ll Pri e

0 100 - .00 0 .00 0 .00 100 .00 2 .00 0 .00 0 .00 100 .001 110 -1 .4 -20 .00 0 . 80 .00 2 .1 8 20 .00 0 .1 8 120 .002 90 -2 .42 29 .09 -0 .9 7 109 .09 1 .70 -43 .64 -0 .48 76.3 63 105 -1 .3 9 -3 6.3 6 1 .0 4 72 .73 1 .9 4 25 .45 0 .2 4 101 .824 95 -1 .82 1 3 .85 -0 .44 86 .5 8 1 .74 -19 .3 9 -0 .20 82 .425 100 -1 .55 -9 .11 0 .2 7 77 .47 1 .82 8.68 0 .09 91 .10

6 9 6 -1 .74 6 .20 -0 .19 83 .66 1 .75 -7.29 -0 .0 8 8 3 .817 92 -1 .9 7 6.9 7 -0 .2 3 90 .64 1 .67 -6.9 8 -0 .0 8 76.838 88 -2 .2 4 7.88 -0 .2 7 9 8.52 1 .59 -6.68 -0 .0 8 70 .159 84 -2 .5 6 8 .9 6 -0 .3 2 10 7.47 1 .52 -6.3 8 -0 .0 8 6 3 .77

10 80 -2 .9 4 10 .2 4 -0 .3 8 11 7.71 1 .44 -6.0 7 -0 .0 8 5 7.70

Ultr asho rt ETF U ltr a long ETF

Source : Barclays Capital


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Dynamic He dging of Leverage d ET Fs

Shares required to rebalance the hedge :

Index notional to be traded for a 1% move (Dollar Gamma) :

Number of shares to bought/sold is proportional to the daily return of the index

Rebalancing for ultrashorts is three times that of ultralongs

E.g. a 5% move in the index > Ultrashort ETF needs to trade 30% of its AUM from the previous day

100

1%1 ETF

t ETF

P mm Dolla r !+

Indext ETF

t Indext

ETF

t Indext

ETF

t P P

r r

mm P P

m P P

m ! 1111


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37

Impact on Market Volatility

Does leveraged ETF hedging add to market volatility?

Issue attracted much attentionPossible measure correlation between return till 30 minutes before close and return in last half hour of trading

At broad market level, little impact on correlation with advent of leveraged ETFs

However, in some sectors (real estate) rebalancing flows have had measurable effect

Rebalance flo ws effect on SPY ret u rns

-40 %

-20 %

0 %

20 %

40 %

60 %

80 %

2001 200 2 2 00 3 200 4 2 005 200 6 2 00 7 200 8 2 009S P

(

) 0 rr 1 l2 ti 0 3 (P r 1 v ) l0 s 1 -15 3 0 R 1 tur 3 vs 15 3 0 -1 600 R 1 tur 3 )

Rebalance flo ws effect on IYR ret u rns

-20 %

-10 %

0 %

10 %

20 %

3 0 %

40 %

50 %

60 %

70 %

80 %

2005 200 6 2 00 7 200 8 2 009I

(

R ) 0 rr 1 l2 ti 0 3 (P r 1 v ) l0 s 1 -15 3 0 R 1 tur 3 vs 15 3 0 -1 600 R 1 tur 3 )

So ur c 4 : B5 r cl5 ys 6

5 pit5 l, F 5 s tTick


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38

Analyst Certifications an d Important Disclos u res Analyst Certification

I, Maneesh Deshpande, hereby certify (1) that the views expressed in this research report accurately reflect my personal views about any or all of the subject securities or issuers

referred to in this research report and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report.Important Disclosures

Barclays Capital does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interestthat could affect the objectivity of this report.

Customers of Barclays Capital in the United States can receive independent, third-party research on the company or companies covered in this report, at no cost to them, wheresuch research is available. Customers can access this independent research at www.lehmanlive.com or can call 1-800-253-4626 to request a copy of this research.

Investors should consider this communication as only a single factor in making their investment decision.

The analysts responsible for preparing this report have received compensation based upon various factors including the Firm's total revenues, a portion of which is generated byinvestment banking activities.

For current important disclosures regarding companies that are the subject of this research report, please send a written request to : Barclays Capital Research Compliance, 745Seventh Avenue, 1 7th Floor, New York, NY 10019 or refer to the firm's disclosure website at www.lehman.com/disclosures. On September 20, 2008, Barclays Capital acquired

Lehman Brothers' North American investment banking, capital markets, and private investment management businesses. All ratings and price targets prior to the acquisition daterelate to coverage under Lehman Brothers Inc.

Options are not suitable for all investors. Please note that the trade ideas within this report do not necessarily relate to, and may directly conflict with, the fundamental ratings appliedto Barclays Capital Equity Research. The risks of options trading should be weighed against the potential rewards.

Risks

Call or put purchasing : The risk of purchasing a call/put is that investors will lose the entire premium paid.

Uncovered call writing : The risk of selling an uncovered call is unlimited and may result in losses significantly greater than the premium received.

Uncovered put writing : The risk of selling an uncovered put is significant and may result in losses significantly greater than the premium received.

Call or put vertical spread purchasing (same expiration month for both options) : The basic risk of effecting a long spread transaction is limited to the premium paid when the positionis established.

Call or put vertical spread writing/writing calls or puts (usually referred to as uncovered writing, combinations or straddles (same expiration month

for both options) : The basic risk of effecting a short spread transaction is limited to the difference between the str ike prices less the amount received

in premiums.

Call or put calendar spread purchasing (different expiration months7

short must expire prior to the long) : The basic risk of effecting a long calendar spread transaction is limited tothe premium paid when the position is established.


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39

Important Disclos u res contin ue d

Because of the importance of tax considerations to many options transact ions, the investor considering options should consult with his/her tax advisor as to how taxes affect theoutcome of contemplated options transactions.

Supporting documents that form the basis of our recommendations are available on request.The Options Clearing Corporation's publication, "Characteristics and Risks of Standardized Options", is available at http ://www.theocc.com/publications/risks/riskchap1.jsp

Barclays Capital offices involved in the production of Equity Research :

London

Barclays Capital, the investment banking division of Barclays Bank Plc (Barclays Capital, London)

New York

Barclays Capital Inc. (BCI, New York)

Tokyo

Barclays Capital Japan Limited (BCJL, Tokyo)

So Paulo

Banco Barclays S.A. (BBSA, So Paulo)

This publication has been prepared by Barclays Capital; the investment banking division of Barclays Bank PLC, and/or one or more of its affiliates as provided below. This publicationis provided to you for information purposes only. Prices shown in this publication are indicative and Barclays Capital is not offering to buy or sell or soliciting offers to buy or sell anyfinancial instrument. Other than disclosures relating to Barclays Capital, the information contained in this publication has been obtained from sources that Barclays Capital believes tobe reliable, but Barclays Capital does not represent or warrant that it is accurate or complete. The views in this publication are those of Barclays Capital and are subject to change,and Barclays Capital has no obligation to update its opinions or the information in this publication. Barclays Capital and its affiliates and their respective officers, directors, partnersand employees, including persons involved in the preparation or issuance of this document, may from time to time act as manager, co-manager or underwriter of a public offering or otherwise, in the capacity of principal or agent, deal in, hold or act as market-makers or advisors, brokers or commercial and/or investment bankers in relation to the securities or related derivatives which are the subject of this publication.

The analyst recommendations in this report reflect solely and exclusively those of the author(s), and such opinions were prepared independently of any other interests, includingthose of Barclays Capital and/or its affiliates.

Neither Barclays Capital, nor any affiliate, nor any of their respective officers, directors, partners, or employees accepts any liability whatsoever f or any direct or consequential lossarising from any use of this publication or its contents. The securities discussed in this publication may not be suitable for all investors. Barclays Capital recommends that investorsindependently evaluat e each issuer, security or instrument discussed in this publication and consult any independent advisors they believe necessary. The value of and income fromany investment may fluctuate f rom day to day as a result of changes in relevant economic markets ( including changes in market liquidity). The informat ion in this publication is notintended to predict actual results, which may differ substantially from those reflected. Past performance is not necessarily indicative of future results.


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40

Important Disclos u res contin ue d

This communication is being made available in the UK and Europe to persons who are investment professionals as that term is defined in Article 19 of the Financial Services andMarkets Act 2000 (Financial Promotion Order) 2005. It is directed at, and therefore should only be relied upon by, persons who have professional experience in matters relating toinvestments. The investments to which it relates are available only to such persons and will be entered into only with such persons. Barclays Capital is authorized and regulated bythe Financial Services Authority (FSA) and member of the London Stock Exchange.

Barclays Capital Inc., US registered broker/dealer and member of FINRA (www.finra.org), is distributing this material in the United States and, in connection therewith acceptsresponsibility for its contents. Any U.S. person wishing to effect a transaction in any security discussed herein should do so only by contacting a representative of Barclays Capital Inc.in the U.S. at 745 Seventh Avenue, New York, New York 10019.

Subject to the conditions of this publication as set out above, ABSA CAPITAL, the Investment Banking Division of ABSA Bank Limited, an authorised financial services provider (Registration No. : 1986/004 794/06), is distributing this material in South Africa. Any South African person or entity wishing to effect a transaction in any security discussed hereinshould do so only by contacting a representative of ABSA Capital in South Africa, 15 ALICE LANE, SANDTON, JOHANNESBURG, GAUTENG, 2196. ABSA CAPITAL IS AN

AFFILIATE OF BARCLAYS CAPITAL.

Non-U.S. persons should contact and execute transactions through a Barclays Bank PLC branch or affiliate in their home jurisdiction unless local regulations permit otherwise.

In Japan, this report is being distributed by Barclays Capital Japan Limited to institutional investors only. Barclays Capital Japan Limited is a joint-stock company incorporated inJapan with registered office of 2-2-2, Otemachi, Chiyoda-ku, Tokyo 100-0004, Japan. It is a subsidiary of Barclays Bank PLC and a registered financial instruments firm regulated bythe Financial Services Agency of Japan. Registered Number : Kanto Zaimukyokucho (kinsho) No. 143.Barclays Bank PLC Frankfurt Branch is distributing this material in Germany under the supervision of Bundesanstalt fr Finanzdienstleistungsaufsicht (BaFin).

IRS Circular 230 Prepared Materials Disclaimer : Barclays Capital and its affiliates do not provide tax advice and nothing contained herein should be construed to be tax advice.Please be advised that any discussion of U.S. tax matters contained herein (including any attachments) (i) is not intended or written to be used, and cannot be used, by you for thepurpose of avoiding U.S. tax-related penalties; and (ii) was written to support the promotion or marketing of the transactions or other matters addressed herein. Accordingly, youshould seek advice based on your particular circumstances from an independent tax advisor.

Copyright Barclays Bank PLC (2009). All rights reserved. No part of this publication may be reproduced in any manner without the prior written permission of Barclays Capital or any of its affiliates. Barclays Bank PLC is registered in England No. 102616 7. Registered office 1 Churchill Place, London, E14 5HP. Additional information regarding this publicationwill be furnished upon request.

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